Bond quesstions dirty full price Fixed income

7. Consider a 4.5% bond maturing September 1, 2014.

the bond and the accrued interest d a i l y for the period September 2, 2013 to August 31, 2014 inclusive (approximately one year). Assume a constant yield of 4.5%. Use a par value of 100, a frequency of 2, and a day count basis of 1. Also calculate the dirty (or full) price for each day. (b) [7] In a graph, plot both the clean and dirty prices. Give your chart a title and label the axes. (c) [4] Change the day count basis to 0. Verify by hand that the clean price and accrued interest given by Excel for December 1, 2013 are correct. (d) [1] Change the day count basis back to 1. Change the yield to 3% and again plot both the clean and dirty prices. (e) [1] With a day count basis of 1, change the yield to 5% and again plot both the clean and dirty prices. (f) [1] (g) [1] Why do you think bond prices are quoted in Canada and the U.S. as clean prices? Note: Provide three graphs and answers to (c), (f), and (g). 8. A portfolio manager with a six-year investment horizon is considering buying one of two bonds. Bond A matures in three years and has a coupon rate of 4.50% payable semi- annually. Bond B, of the same credit quality, matures in ten years and has a coupon rate of 4.55% payable semi-annually. Both bonds are priced at par. To assist in selecting between the two bonds, the portfolio manager decides to conduct some horizon analysis. He considers the following two scenarios: Scenario 1: Reinvestment rate, next 4 years 5% Reinvestment rate, years 5 and 6 7% Yield on 4-year bond in 6 years 6% Scenario 2: Reinvestment rate, next 4 years 3% Reinvestment rate, years 5 and 6 5% Yield on 4-year bond in 6 years 5% Note that the above interest rates are all expressed as annual rates compounded semi- annually. (a) [10] What bond should the portfolio manager buy? To answer this question, calculate total return expressed as a percentage. Show your work. In your calculations, assume a par value of $100. (b) [2] Suppose that reinvestment rates are assumed to be as given in scenario 2 but the yield on a 4-year bond in 6 years is assumed to be 6%, rather than 5%. Does this alter the conclusion that you have reached in (a)? Explain briefly. No calculations are required.